Even if you're a stock investor, now! Advantages of focusing on bonds

Recently, US bond yields have continued to rise rapidly, and global financial markets are in an unstable state. In the world's largest bond marketvolatilityWhat does a rise in yield mean among some investors? What is the relationship between inflation and the Fed's monetary policy and government bond yields? It seems that such concerns are growing.

This time, we will be discussing the bond market, which has an impact on the global economy.

First, it is used in the bond marketInterest rate, yield, maturity, redemptionLet's understand specific terms such as

The largest stock market in the world is the US.

And the country with the biggest bond market in the world is America too!

As of 2023, the total value of the US bond market51 trillion dollarsIt has surpassed and accounts for 41% of the global market.

Thanks to this enormous size, the US bond market is widely considered to be the most liquid and dynamic in the world. The US bond market not only reflects the dynamics of global financial markets, but is also said to influence the price formation of other financial assets such as stocks and exchange rates.

In the US bond market,Government bonds, corporate bonds, municipal bonds, mortgage-backed securitiesThere are several types of bonds, such as, but the US Treasury Department issues themUS bonds (treasury)It is considered the most important.

Because US bonds are backed by the US government, they are considered nearly risk-free. Because of this characteristic, it has been selected as an investment target considering interest rates among countries and individual investors around the world.

That is Japan!Government of JapanIt seems that the amount of US bonds held will rise to about 1.1 trillion US dollars as of 2023/7. (Source: US Treasury)

US bonds are used by the federal government to cover its expenses, and have various repayment periods from 1 month to 30 years. What are US bondsShort-term bonds(1 year or less),Medium-term bonds(2 to 10 years),Long-term bondsIt is classified by the period until redemption (over 10 years).

What is the interest rate that the government pays on government bondsGovernment bond yieldIt is called, and reflects both government funding costs and investors' expectations about the future prospects of the economy.

Short-term interest ratesis most sensitive to changes in monetary policy, and it is said that these fluctuations are often larger than fluctuations in long-term government bond yields.Medium- to long-term government bond yields are based on investors' expectations for future US economic conditionsTerm Premium(Term premium) has been added to short-term government bond yields.

Therefore, there is a possibility that changes in short-term government bond yields will have an impact on medium- to long-term government bond yields.

Now, will the rise in US bond yields affect the US Treasury's burden (interest payments) on US bonds? Is there anyone who wonders?

ActuallyThe cost of issuing US bonds by the US Treasury is fixed at the time of issuanceThat's it. Therefore,Changes in US bond yields have no effect on the cost of debt balances! If interest rates rise and national debt increases, there is a high possibility that future borrowing costs will rise. However, there is a possibility that rising yields will lower the nominal value of US bonds.

The value of a bond is determined by the bond price and yield, bond prices and yields are inversely proportional.

An increase in yield means that demand for government bonds is declining, and investors may instead look at high-risk, high-return investments (higher interest rates increase the subtlety of bond investment, but it is necessary to keep in mind the decline in bond prices).

The factors that influence government bond yields are categorized and organized.

① Investor sentiment: When investors' confidence in the market declines, bond prices rise, and yields tend to fall. The reason behind this is that in times of high uncertainty, investors tend to flock to relatively safe investment targets such as government bonds, leading to a decline in yields. (bond buying → rising bond prices & falling yields)

② Monetary policy: Investors keep a close eye on 10-year bond yields as a benchmark for interest rates, but they may also be affected by fluctuations in short-term interest rates. For example, if the Federal Reserve (Federal Reserve) raises interest rates,Federal funds rate(Policy interest rates) will rise, which will have a direct impact on government bond yields.

③ Inflation expectations: What is the yield on US Treasury bondsReal interest ratewithInflation expectationsIt can be divided into, and market inflation expectations can have a big impact on the rise or fall of yields. Furthermore, there is a possibility that the announcement of unexpected economic indicators will also have a big impact on government bond yields. For example, in the inflation suppression phase, when CPI (consumer price index), PCE (personal consumption expenditure), number of people employed in the non-farm sector, and unemployment rate (employment statistics) exceed market expectations, it means that the US economy, which is regarded as strong, supports additional interest rate increases by the Fed.

④ Emerging events: Geopolitical disputes and wars can cause short-term yield fluctuations. When uncertainty increases, investors evacuate funds from the stock market to the bond market (buying bonds), and yields fall. Conversely, there is a possibility that geopolitical tension involving major oil producers will raise inflation expectations and put upward pressure on government bond yields.

Not only bond investors, but also stock investors can deepen their understanding of market conditions and investor sentiment by looking at the bond market.

And right now! It is thought that the need for this is increasing, isn't it?

We will organize the main indicators of bonds.

① 10-year bond yield: When you join a securities company, you first look at trends in US 10-year bonds and then 2-year bonds every day, so much so it's a must in the financial industry. The 10-year bond yield can be used as a benchmark for other interest rates, such as mortgage interest rates and corporate bond interest rates. Also, 10-year bond yields are thought to be an expression of investors' confidence in the market.

② USD: The trend of the US dollar, which is the world's key currency, will have a major impact on the US bond market. If the appreciation of the dollar progresses, there is a possibility that overseas investors will look at the US bond market, demand for bonds will increase, bond prices will fall, and yields will rise.

③ VIX Index (CBOE Volatility Index): The VIX index reflects market expectations for the volatility of the S&P 500 index over the next 30 days. As market risk appetite declines and investors' concerns about the market intensify, the VIX index rises, which tends to boost demand and prices for safe assets such as US bonds.

It is common for government bond yields to increase as maturity approaches. In other words, if you buy a bond, you can expect higher returns by holding funds for a long period of time.

And usually, short-term bonds have lower yields than long-term bonds. Therefore, plotting a bond yield curve from 1 month to 30 years on the X axis should show an uptrend curve, also known as a normal yield curve.

BUT! The yield curve is reversed, that isThe yield on short-term bonds exceeds the yield on long-term bondsThere are cases. In such cases, the yield curve draws a downward slope,reverse yield curveIt's called.

Currently, the yield curve for US bonds has been reversed,The 2-year yield and 10-year yield will remain reversed from 2022/7It is.

... for quite some time,reverse yield stateIt's in!

The recent rise in yield is thought to be due to the Fed's monetary tightening. To counter high inflation, the Fed raised policy interest rates a total of 11 times from 2022/3 to 2023/10, and expanded the range of interest rate increases from 5.25% to 5.50%. It's fresh in my memory that this sense of speed of interest rate hikes became a hot topic.

The Fed's aggressive interest rate hikes will slow the growth of the US economy,recessionIsn't it going to lead to (economic recession)? It made many investors uneasy.

In this case, investors tend to flee to long-term government bonds, push up government bond prices (buy bonds), and lower yields. It is thought that this is why the yield on long-term bonds, such as 10-year bonds, is lower than that of short-term bonds.

A reverse yield situation is a rare event that indicates long-term concerns for the market. Since many banks rely on the business model of paying short-term interest rates to depositors and obtaining interest from long-term loans, reverse yield conditions tend to be unfavorable to banks. As a result, the retrograde phenomenon of the yield curve hinders bank profitability (bank stock sales, etc. can be considered in association).

Looking back on history,Difference between 10-year government bond yields and 2-year government bond yieldsIsrecessionIt has functioned as a harbinger of (economic recession). When the yield curve is normal, the difference is usually positive, indicating future economic stability. However, when there is a reverse yield state, the difference becomes negative, which is a sign that a recession is approaching.

10-year yield and 2-year yieldspreadsWhen (interest rate difference) becomes negative in the reverse yield state, a recession has occurred within 6 to 24 months, according to past rules of experience! Since it accurately predicts all recessions from 1955 to 2018, reverse yield is considered a leading indicator of the market.

According to the Chicago Fed chart, since the 1970s,yield spreadis negative every time before a recession, and the shaded part represents each recession.

This indicates that short-term interest rates are higher than long-term interest ratesreverse yield curveis often viewed as a warning of an impending recession!

Currently, the yield curve of US bonds is graduallyflatten(Flattened), and yields appear to be converging.

However, since the reversal of yield curves between 2-year bonds and 10-year bonds often precede significant bond sales (interest rates rise), which is regarded as an indicator of an impending recession, the market still sees this trend as a warning sign.

Duke University Professor Campbell Harvey predicts that a recession is likely to occur in the first or second quarter of 2024, and could pose significant risks to the financial system.

This is why bonds are currently in the spotlight in the market.

I think you, who are stock investors, now understand that this is a very important topic.

If you have any future strategies or investment ideas, please share them!